Quick Lower Middle Market Lesson: Cash is still king.
A company may be "highly profitable" in terms of adj EBITDA. Dig beneath that number and you may find a situation in which cash distributions are impossible. In fact, the company eats cash.
How could a company eat its cash?
A company may be "highly profitable" in terms of adj EBITDA. Dig beneath that number and you may find a situation in which cash distributions are impossible. In fact, the company eats cash.
How could a company eat its cash?
We most commonly see 3 ways:
1. CAPEX: We regularly see orgs where annual maintenance CAPEX is 1/5-1/3 of EBITDA (or more). That's *before* thinking about growth investments in new equipment to increase capacity/capability.
1. CAPEX: We regularly see orgs where annual maintenance CAPEX is 1/5-1/3 of EBITDA (or more). That's *before* thinking about growth investments in new equipment to increase capacity/capability.
2. Inventory: If growth requires more stock, any new proceeds often end up there - not in shareholders' profits. Use LOCs or floor lines? Don't forget the interest on those either.
3. Floats, Terms & Covenants: If B2B, payment terms can kill via float requirements, resulting bad debt, etc. If biz requires bonding, cash required on balance sheet may far exceed "normalized" amount (think up to 6X is some cases).
I had an advisor tell me this week that, as a private biz, their client didn't really need to track things like CAPEX and that it shouldn't be relevant to our understanding of the biz/opp either. That could not be further from the truth - for either party.
